Must-know: Minimum wage of $7.25 isn’t as low as people may think

Companies, including large consumer staple companies in the Consumer Staples Select Sector SPDR (XLP) and Vanguard Consumer Staples ETF (VDC), aren’t going to budge because they don’t regulate wages. On one side, making sure every citizen is above the poverty level sounds like a basic right. But note the $7.50 minimum wage isn’t the lowest we’ve seen over the past 20 years when we adjust for inflation.

In fact, minimum wage in the United States adjusted for inflation is above where it has been over the past 20 years. Note that the CPI tends to overestimate real inflation because it doesn’t fully capture the substitution effect—when prices of alternative goods become cheaper, consumers switch their purchases. Nor does it fully reflect changes in consumer purchases or increases in quality.

Since minimum wage isn’t near the lows we’ve seen before, why are people proposing strikes now? Perhaps this is happening because there’s a growing presence of older people who are still working at minimum wage and can’t get out of it because of the current labor market.

What goes around comes around

If that’s the case, is simply increasing minimum wage the answer? No, because the market will likely pass on higher wages to consumers. Wage expense makes up a large chunk of costs for consumer service businesses or retailers. Although some companies are making billions, it’s largely because of their scale. A slight increase in wages can erase profits for these companies. To protect profits, prices will have to rise.

Those who work near minimum wage are also more likely to spend more once they earn more. Seeing that minimum wage workers are willing to spend more, retailers will sell goods at higher prices as demand goes up. Essentially, what goes around comes around, and the minimum wage workers who received higher wages will just be hit in the back in the future.

Alternatively, corporations can also increase capital spending to increase productivity, which could lead to some layoffs. The next part of this series will address this option.